Inheriting assets or property can be a mixed emotional experience. While you navigate the process of grieving and estate settlement, it's important to consider the potential tax implications of your newfound wealth. In this guide, we'll break down the basics of how inheritances are taxed and provide insights on ways to protect your inheritance from unnecessary tax burdens.
Understanding Inheritance Tax
The taxation of inheritance can vary significantly based on where you live and the nature of the assets you inherit. Contrary to common belief, the United States federal government does not impose an inheritance tax on beneficiaries. Instead, the federal estate tax is levied on the estate of the deceased, meaning that estates exceeding a certain value are subject to taxation before assets are distributed to heirs.
However, it's essential to note that some states do have their own inheritance tax laws, which can affect the amount you ultimately receive. Thankfully, the majority of states do not levy inheritance taxes, and if you're not in one of those states, you may be in the clear. To find out whether your state imposes inheritance taxes, you should consult your state's tax department or a knowledgeable tax professional. Schedule a free consultation call with J. Hall & Company founder Josh Hall to learn more about how your inheritance may be taxed.
Federal Estate Tax Considerations
The federal estate tax only applies to estates with a value exceeding a certain threshold, which is adjusted annually for inflation. This threshold is relatively high, ensuring that only a small percentage of estates are subject to federal estate tax. Additionally, surviving spouses are generally exempt from the estate tax when they inherit from their deceased spouse, thanks to the unlimited marital deduction.
However, for non-spouse beneficiaries, the rules are different. If you receive an inheritance that includes assets from an estate that exceeds the federal estate tax threshold, you may be subject to federal estate tax, depending on the total value of the assets you inherit.
State Inheritance Taxes
As mentioned earlier, some states do have their own inheritance tax laws that can affect your inheritance. These taxes are generally based on the value of the assets you inherit and your relationship to the deceased. The tax rates and exemptions can vary widely from state to state, so it's crucial to understand the rules in your specific location.
Ways to Protect Your Inheritance
While you may not have complete control over the taxation of your inheritance, there are several strategies you can employ to help minimize the tax impact:
Consult a Tax Professional: Working with a tax professional who specializes in estate and inheritance taxation can provide you with personalized advice tailored to your situation.
Know Your Basis: The "basis" of inherited assets is generally the fair market value at the time of the decedent's death. This is important because when you sell an inherited asset, your capital gains tax is calculated based on the difference between the sale price and the stepped-up basis. Understanding this concept can help you make informed decisions about selling or holding onto inherited assets.
Consider Estate Planning: While estate taxes are levied on the deceased's estate, proper estate planning can help minimize the overall tax burden. Strategies like setting up trusts, gifting assets, and utilizing exemptions effectively can all contribute to reducing taxes.
Gift and Estate Tax Exemptions: There are federal gift and estate tax exemptions that can allow you to pass on a certain amount of wealth without incurring taxes. Staying informed about the current exemption limits can help you plan accordingly.
Inheriting assets can be a complex process, especially when considering the potential tax implications. Understanding the federal and state laws related to inheritance taxes is crucial for making informed decisions. While tax professionals can provide personalized guidance, arming yourself with knowledge about the basics of inheritance taxation and protective strategies can help you navigate this intricate terrain with greater confidence. Each situation is unique, so it's always a good idea to consult a professional before making any major financial decisions.
At J. Hall & Company, we pride ourselves on superior personalized customer service for all of our clients. You can book a free consultation with our founder Josh Hall to discuss your inheritance-related questions right here.